Sunday, July 13, 2014

Summer Institute

I just got back from the NBER Summer Institute. The Economic Fluctuations and Growth meeting organized by Larry Christiano and Chad Jones sparks some thoughts on where macro is and where we're going. (I also attended the monetary economics and asset pricing meetings, which were excellent and thought provoking too, but one can only blog so much.)

Review:

There were two papers on macro theory. Fist, the conference started with Gauti Eggertsson and Neil Mehrotra's "A Model of Secular Stagnation," which I discussed, slides here.

I think it's an important paper. The standard simple New-Keynesian model has a lot of trouble to produce a steady slump with positive inflation. So if you want "secular stagnation," you need a new model. I also have a lot of trouble with the "negative natural rate." It tends to be a deus-ex-machina, output is lower than I'd like so the natural rate must be negative. It would be much more convincing if we could separately measure the natural rate, but that too needs a model. This paper provides a model whose steady states resemble old fashioned static Keynesian relations, not the dynamic new-Keynesian ones, and a model where one could think about separately measuring the negative natural rate.

"Important" doesn't mean "right" or "conclusive." This model rules out storage, has no money, and hobbles the rate of return on capital, all of which tend to put bounds of zero or above on long-term real interest rates. More thoughts on the slides, which I may write up at more length some day. (Olivier Blanchard discussed the same paper on Friday, bringing in data from around the world. If he posts his slides I'll update.)

Second, Paul Beaudry presented his paper with Dana Galizia, Franck Portier, titled "Reconciling Hayek's and Keynes' Views of Recessions," which Ivan Werning discussed. It was a rather complex model trying to capture overaccumulation and liquidation.

There were two empirical papers. Simon Gilchrist, presented his paper with Raphael Schoenle, Jae Sim, Egon Zakrajsek, "Inflation Dynamics During the Financial Crisis," discussed by Mark Bils. Companies short of cash in the financial crisis raised prices; companies with a lot of cash lowered them. Clean dynamic model, clean data, a nice bit of the micro data analysis going on in macro these days.

Sarah Zubairy presented her paper with Valerie Ramey, "Government Spending Multipliers in Good Times and in Bad: Evidence from U.S. Historical Data," discussed by Yuriy Gorodnichenko. As Valerie has done before, they regress output on military spending shocks to estimate multipliers. Here the question is whether the effects are larger when there is higher unemployment or a low interest rate, with a bunch of small but important methodological improvements. The conclusion is no, and multipliers a bit below one throughout, but much methodological discussion on how one interprets the facts.

There were two "Growth" papers. First, Roland Benabou presented "Forbidden Fruits: The Political Economy of Science, Religion and Growth" with Davide Ticchi and Andrea Vindigni. The basic idea is that religion blocks or adapts to new ideas, going back centuries. History, going back a thousand years, regressions of patents on religiosity, all building to a big model, with section titles like "Inequality, Religion and the Politics of Science."

Paul Romer "discussed" the paper, i.e. gave a long and thoughtful speech, covering religion, social norms, neuroeconoimcs (Southerners faced with a slight insult have big spikes in cortisol levels compared to Northerners), the shocking rate of incarceration in the US, words vs. equations in economics, and lots more.

Last but certainly not least, Ufuk Akcigit presented "Young, Restless and Creative: Openness to Disruption and Creative Innovations" with Daron Acemoglu and Murat Alp Celik, discussed by Sam Kortum, The basic idea is that companies with young CEOs are more likely to make radical innovations rather than incremental ones. A complex model precedes regressions of patent citations on CEO age.

Thoughts:

Just how we do economics was a big theme running through all the discussion. Words vs. equations; models and empirical work; and what kinds of things we look at and what kind of work people are doing.

Most of the theory papers had some "motivating" facts. Most of the facts papers and more or less motivating theory. Not one paper wrote down a model, estimated or calibrated its parameters, and compared that model to data. (Gilchrist came pretty close, but more the exception that proves the rule.) This isn't a complaint, really, it's just where we are. The kinds of things people want to investigate are just too hard to write down models rich enough to take to the data.

This point came up again and again. Sam gently chided Ufuk at al for presenting 24 pages of complex model all to "motivate" some regressions. He suggested that the model should be used to guide and constrain regressions, and to give a more structural interpretation to the parameters. Pat Kehoe, asking a question, complained that it's awfully hard to measure a fiscal multiplier with no guidance of which model for its possible operation. He pointed out that any model restricts how many variables together should respond to a fiscal expansion. For example the static Keynesian model says consumption should rise. The real business cycle model gives a multiplier through impoverishing people, which has joint predictions across consumption, labor, etc. Likewise I complained that in wars, the assumption that everything else is on average equal -- made when regressing output on fiscal shocks -- seems a bit stretched.

Similarly, both of the macro theory papers stopped well short of serious confrontation with data. We didn't see anything like the standard fully specified models of the Larry Christiano type, compared to, say, impulse-response functions. The models are so stylized you can't begin to quantify them. (I got off cheap shot pointing out that secular stagnation required deflation in the model. Since we do not have deflation, case closed. It's a cheap shot because I think the model could be easily modified to have stagnation with low positive inflation.) This too is not really a criticism. I've been working with simpler and simpler models, as I find it hard to keep the intuition and quantitative parable aspect alive as models get more complex. You have to walk before you can run. But questions like, how could Ed Prescott and Ellen McGrattan go off and measure the natural rate, are not yet answered.

A similar issue came up in the paper I discussed for Asset Pricing, Aytek Malkhozov, Philippe Mueller, Andrea Vedolin, and Gyuri Venter "Mortgage Risk and the Yield Curve," slides here. It developed a really nice arbitrage-free model with supply effects. And then used the model only to "motivate" regressions of returns on a measure of duration. Though the regression coefficient is tied to structural model parameters, the authors never made that link at all. Well, the model was perhaps too simple to do that. And, everyone else seems to be writing papers the same way. It's not a criticism, here, but an observation on our emerging culture.

Math vs. literature is a similar theme to atheoretical regressions/models as parables vs. estimates and tests. In my 30 years as an economist, our field has become much more literary and less quantitative. In part that reflects a different emphasis. It's really hard to build towards maximum likelyhood tests of effects of religion on the adoption of new ideas. Paul Romer commented on this at length, with "models vs. words" on his slides. In his view, math is a useful language because it removes much of the value-laden elements of language and forces logic to be out in the open. He linked language to us vs. them, social norms, morality, and those pesky cortisol levels. (I'm doing my best to recall a speech, so forgive me Paul if I don't get it all right.) He pointed to my use of "paleo-Keynesian" to describe the static models from the 1960s, guessing nobody would remember anything else from my discussion. When I complained that Paul Krugman invented the term, he pointed out (correctly) that such borrowing just made its use more rhetorically effective. There go the cortisol levels. I'm not sure in the end though whether Paul was approving or bemoaning the shift back towards literature in economic analysis. Certainly his vision for the future of growth theory, centered on values, social norms, biology, and so forth, does not lend itself easily to quantification.

The use of ancient quotations came up several times. I complained a bit about Eggertsson and Mehrotra's long efforts to tie their work to quotes from verbal speculations of Keynes, Alvin Hansen, Paul Krugman and Larry Summers. Their rhetorical device is, "aha, these equations finally explain what some sage of 80 years ago or Important Person today really meant." Ivan Werning really complained about this in Paul Beaudry's presentation. What does this complex piece of well worked out "21st century economics" have to do with long ago muddy debates between Keynes and Hayek? It stands on its own, or it doesn't. (In his view, it did, so why belittle it?)

Yes. Physics does not write papers about "the Newton-Aristotle debate." Our papers should stand on their own too. They are right or wrong if they are logically coherent and describe the data, not if they fulfill the vague speculations of some sage, dead or alive. It's especially unhelpful to try to make this connection, I think, because the models differ quite sharply from the speculations of the sage. Alvin Hansen certainly did not think that a Taylor interest rate rule with a phi parameter greater than one was a central culprit in "secular stagnation." I haven't checked against the speech, but I doubt he thought that inflation would completely cure the problem in the first place.

Sure, history of thought is important; tying ideas to their historical predecessors is important; recognizing the centuries of thinking on money and business cycles is important. But let's stand up for our own generation; we do not exist simply to finally put equations in the mouths of ancient economists.

But, tying it all up, perhaps I'm just being an old fogey. Adam Smith wrote mostly words. Marx like Keynes wrote big complicated books that people spent a century writing about "this is what they really meant." Maybe models are at best quantitative parables. Maybe economics is destined to return to this kind of literary philosophy, not quantified science.

Curious too what was missing. All the macro was decidedly Keynesian. General equilibrium with distortions, anything other than trend on "supply" was noticeable by its absence. So was the discussion. But maybe that's my fault for going to the NBER and not the Minnesota Macro meetings.

A last thought. Economic Fluctuations merged with Growth in the mid 1990s. At the time there was a great confluence of method as well as interest. Growth theorists were studying growth with Bellman equations, dynamic general equilibrium models of innovation and transmission of ideas, thinking about where productivity shocks came from. Macroeconomists were using Bellman equations, and studying dynamic general equilibrium models with stochastic technology, along with various frictions and other propagation mechanisms.

That confluence has now diverged. I enjoyed spending an hour or two thinking about how religion has blocked or adapted to ideas over the centuries, and Paul's view on social norms or neuroeconomics. But I don't really have any expertise to contribute to that debate. Questions like whether young CEOs head more innovative companies, or whether, like deans, what matters is the age of the faculty are a little closer to home, since I spend a lot of time consuming corporate finance. But the average sticky-price macro type does not. Likewise, when Daron Acemoglu, who seems to know everything about everything, has to preface his comments on macro papers with repeated disclaimers of lack of expertise, it's clear that the two fields really have gone their separate ways. Perhaps it's time to merge fluctuations with finance, where we seem to be talking about the same issues and using the same methods, and growth to merge with institutions and political or social economics.

I read your slides on the secular stagnation papers. They don't seem to incorporate international forces. You note yourself that lending abroad means that r will not be negative. But this does not consider the special role of the US dollar - what some have dubbed exorbitant privilege. Assets denominated in US dollars should sell at a premium. That is how I understand a negative real rate in the US but not in Australia, Canada, Israel, etc, and why the European Central Bank has ventured into parking fees on reserves held there.

You also point out that storage prevents negative real rates. But we do have a problem with storage. In Canada and Australia there is plenty of talk of housing bubbles. And in London and New York, overseas buyers are even bidding up apartments without looking at them or intending to live in them.

I also have “trouble with the negative natural rate.", or to be blunt, I think it’s hogwash. It’s based on the assumption that adjusting interest rates is the only or the only possible way of adjusting demand.

That’s nonsense: in a recession, the state could perfectly well go wild with the printing press, i.e. print and spend far too much new money into the economy. That would cure or largely cure the recession, but to deal with the excess demand, interest rates would have to be raised. Indeed, the latter idea is very much what market monetarists like Scott Sumner argue. That is they argue that the central bank will always negate excess fiscal stimulus.

"Perhaps it's time to merge fluctuations with finance, where we seem to be talking about the same issues and using the same methods, and growth to merge with institutions and political or social economics. "

Makes a lot of sense. Although I agree more with the "same issues" than "same methods". I think economics given the nature of the discipline, should be eclectic and open-minded in relation to methodology. We are after all trying to end recessions the best way we can and we should be constantly looking for the best way to do understand their causes. That might not be the way finance currently does things. I think a big criticism in macro-teaching of the last 40 years is a lack of critical reasoning that asks why a certain methodology has become prominent.

Alright it is the job of politicians who act on the advice of economists.

Whoops that is not right either. Politicians do not act on the advice of economists. Probably not a bad idea either. Unless they want to lose their job. (Economists do not have to worry about their forecasts or prescriptions being wrong or losing their jobs - most of them are tenured professors or work in the finance industry - the latter particularly ingenious at justifying wages and jobs that bear no relation to MP.)

Yep, I tend to agree: "Perhaps it's time to merge fluctuations with finance, where we seem to be talking about the same issues and using the same methods, and growth to merge with institutions and political or social economics." Of course, on the econometric side, the NBER's Forecasting and Empirical Methods in Macro and Finance group did that years ago. Perhaps more on that in my next No Hesitations post.

I have long given up on keeping up. Regardless, I read recently an excellent "bubbles paper", by Stephano Giglio et al (Boothe) in which they have nearly the exact data one would want from a controlled experiment to resolve if bubbles drove UK property prices. Just to meddle, I proposed a non regression way to exploit their remarkable data. Have a look

"I complained a bit about Eggertsson and Mehrotra's long efforts to tie their work to quotes from verbal speculations of Keynes, Alvin Hansen, Paul Krugman and Larry Summers. Their rhetorical device is, "aha, these equations finally explain what some sage of 80 years ago or Important Person today really meant." "

I like historical allusions. Even in physics, the old guys may be worth reading. Certainly that's true of math--- Euclid and Hilbert may not be up to date, but they are suggestive of roads not pursued. Econ ever more so, because it's harder to get a grip on things. What we need to avoid, tho, is discussion of "what Keynes really meant." The reason is that he didn't know what he meant--- he had some good intuitions that we ought to pay attention to, but their value is in stimulating us now to pursue an idea, not to try to rediscover anything.

"The Age of Enlightenment (or simply the Enlightenment or Age of Reason) was a cultural movement of intellectuals beginning in late 17th-century Europe emphasizing reason and individualism rather than tradition. Its purpose was to reform society using reason, to challenge ideas grounded in tradition and faith, and to advance knowledge through the scientific method."

"The chief characteristic which distinguishes the scientific method from other methods of acquiring knowledge is that scientists seek to let reality speak for itself, supporting a theory when a theory's predictions are confirmed and challenging a theory when its predictions prove false."

From John's article:

"I complained a bit about Eggertsson and Mehrotra's long efforts to tie their work to quotes from verbal speculations of Keynes, Alvin Hansen, Paul Krugman and Larry Summers."

And

"Our papers should stand on their own too. They are right or wrong if they are logically coherent and describe the data, not if they fulfill the vague speculations of some sage, dead or alive."

What John says is that rather than relying on experimentation to verify / disprove their theory, Eggertsson / Mehrotra instead sought confirmation through the proclamations of "some sage".

The problem with properly applying the scientific method to any endeavor is identifying and eliminating bias and observer effects. An example of observer effect in economics is described here:

http://en.wikipedia.org/wiki/Hawthorne_effect

Imagine if Newton had to worry about observation effects when formulating classical mechanics. Fortunately for Newton, the apple was emotionless before striking him on the head. If the apple was shy, it might have diverted course. If the apple was aggressive, it might have struck him harder than expected.

"One cannot just dismiss, out of hand, a discipline simply because all of its propositions are not deducible from some set of fundamental propositions."

If a proposition is not deducible from some set of fundamental proposition then it may be an undiscovered fundamental proposition in and of itself. The number of fundamental propositions can be limitless, just as long as they are logically consistent.

Surely, logical consistency between a group of theories in a field of study must be maintained.

"Surely, logical consistency between a group of theories in a field of study must be maintained."

Within a theory yes. Between theories, no. Most certainly not. That is the difference between a science and a theology. (A theology may reconcile the theory of evolution and creation; but that is not the job of a science or social science).

We have to accept that there may be a different explanation of how things work which is not consistent with how another theory explains how it works. For example a Marxian. Realist or Liberal explanation of the relationship between states. All very plausible and coherent explanations but all cannot be theoretically right at the same time. We use these as reference points. The proof is in the empirical/historical study which should not make any assumptions about anything being axiomatic.

In theory all such theories cannot be right at the same time. In real world complexity, all the theories and none of them are probably going to be right at the same time!

"We have to accept that there may be a different explanation of how things work which is not consistent with how another theory explains how it works...All very plausible and coherent explanations but all cannot be theoretically right at the same time."

Doesn't a government legislated legal framework reduce the number of plausible economic theories?

Granted that legal structure is subject to flux - laws get written, re-written, and destroyed. Granted also, that a legal system is something that is agreed upon by a group of people and may apply only to that group.

Nonetheless, doesn't a government mandated legal system provide a formal axiomatic system under which economics operates?

Thanks to a few abusers I am now moderating comments. I welcome thoughtful disagreement. I will block comments with insulting or abusive language. I'm also blocking totally inane comments. Try to make some sense. I am much more likely to allow critical comments if you have the honesty and courage to use your real name.

About Me and This Blog

This is a blog of news, views, and commentary, from a humorous free-market point of view. After one too many rants at the dinner table, my kids called me "the grumpy economist," and hence this blog and its title.
In real life I'm a Senior Fellow of the Hoover Institution at Stanford. I was formerly a professor at the University of Chicago Booth School of Business. I'm also an adjunct scholar of the Cato Institute. I'm not really grumpy by the way!